Can the general contractor refuse to pay for the goods if they do not release funds?

This article is reprinted from: Guangxi Legal Daily

Can the general contractor refuse to pay for goods just because it hasn’t released funds?

Court: “Back-to-back” payment arrangements in the construction industry cannot be indefinitely delayed and evaded; the outstanding debts should be repaid

□ Correspondent: Qin Kun

In the construction industry, the saying “The general contractor hasn’t paid me, so I can’t pay you for the goods” often leaves countless building-material suppliers stuck in payment-recovery difficulties. So can this so-called “back-to-back” payment arrangement truly serve as a lawful reason to withhold payment for unpaid goods? Recently, the Yulin Intermediate People’s Court issued a final judgment in a construction-materials sales contract dispute involving “back-to-back” clauses, clearly defining the judicial recognition rules for such clauses and drawing a legal red line for transactions in the local construction market.

A dispute triggered by long-delayed payment of final supply funds

In June 2023, Hai Mou Building Materials Co., Ltd. (hereinafter “Hai Mou Company”) signed a dry-mixed mortar purchase and sales contract with Chuan Mou Construction Engineering Co., Ltd. (hereinafter “Chuan Mou Company”). The contract agreed that Hai Mou Company would supply dry-mixed mortar for a real-estate project contracted by Chuan Mou Company.

In this contract, there was a special provision that is extremely common in the construction industry: Chuan Mou Company would use the general contractor’s allocated project funds to pay Hai Mou Company for the goods. For any project payment arrears caused by reasons not attributable to Chuan Mou Company, Hai Mou Company was not allowed to demand payment from Chuan Mou Company. In other words, the industry’s commonly used “back-to-back” payment clause—using the upstream general contractor’s disbursement as the prerequisite for the downstream construction company to pay the materials supplier.

After the contract was signed, Hai Mou Company continued to supply goods as agreed. By August 2024, after verification and settlement by the designated sign-off parties, the cumulative value of goods supplied by Hai Mou Company exceeded 550,000 yuan. Chuan Mou Company had paid only more than 288,000 yuan, and the remaining goods payment was still not paid for a long time. After repeated unsuccessful attempts to collect the payment, Hai Mou Company sued Chuan Mou Company in the People’s Court of Luchuan County, requesting that it pay the overdue goods payment, late interest, and the attorneys’ fees incurred in safeguarding its rights.

In court, Chuan Mou Company argued in its defense: According to the contract, the prerequisite for payment is the general contractor’s disbursement. At present, the general contractor has not yet settled the engineering payment with the company, so the payment condition has not been met. In addition, Hai Mou Company also has some goods payment that has not been invoiced; therefore, the company has the right to refuse payment.

After trial, the Luchuan County Court ordered Chuan Mou Company to pay Hai Mou Company more than 270,000 yuan in goods payment and the corresponding overdue interest, while dismissing Hai Mou Company’s other claims. Chuan Mou Company, dissatisfied with the first-instance judgment, appealed to the Yulin Intermediate People’s Court.

A single judgment that breaks through the industry’s unclear payment practices

In the second instance, the parties’ dispute centered on whether the “back-to-back” payment clause had legal effect and whether it could serve as a reason for Chuan Mou Company to refuse to pay for the goods.

The court found that the “back-to-back” clause in the contract only stipulated that payment would be conditioned on the general contractor’s disbursement. It did not specify the exact time or amount of the disbursement, nor did it require Chuan Mou Company to have an obligation to actively collect the payment from the general contractor through issuing letters, litigation, or other means. It also did not stipulate what remedies would be available to Hai Mou Company if the general contractor failed to disburse funds for a long period. This means that the timing of Chuan Mou Company’s payment depended entirely on a third party’s actions. Because there was no clear performance deadline, whether and when Hai Mou Company’s creditor’s claim could be realized was in a completely uncertain state.

The court held that, for a conditional civil juristic act, the condition attached must be definite and achievable. Because the “back-to-back” clause at issue had a payment condition that lacked certainty, it should, according to law, be recognized as an unclear agreement on the performance deadline. Under the relevant provisions of the Civil Code, if the performance deadline is unclear, the creditor may request the debtor to perform at any time, and only needs to provide the other party with the necessary time to prepare.

At the same time, this case is a dispute arising from a sales contract. Hai Mou Company has completed the core contractual obligation of supplying goods, and Chuan Mou Company should therefore pay the goods payment. The construction engineering dispute between Chuan Mou Company and the general contractor is two independent legal relationships from the sales contract in this case. Chuan Mou Company may not refuse to fulfill its own contractual obligations on the grounds that the third party has not paid.

Regarding the 3 supply transactions in September 2024, because Hai Mou Company failed to provide the original delivery note(s), and the parties also did not complete the settlement for this portion of the supplies, the second-instance court did not support the payment for this part. Ultimately, the Yulin Intermediate People’s Court made a judgment: while upholding the first-instance court’s legal recognition of the “back-to-back” clause, it lawfully changed the judgment to order Chuan Mou Company to pay Hai Mou Company 263,000 yuan or more in goods payment, and dismissed Hai Mou Company’s other claims.

Judge’s Reminder

When signing “back-to-back” clauses, these details must be clearly written

“Back-to-back” payment clauses, in essence, shift the settlement risk from upstream to downstream materials suppliers, and in practice they can easily trigger payment-recovery disputes.

The presiding judge pointed out that such clauses are not automatically invalid. However, for them to have legal binding force, certain necessary prerequisites must be satisfied: first, the final payment deadline must be clearly agreed and payment cannot be delayed indefinitely; second, it must be clearly agreed that the payer has an obligation to actively assert its creditor’s claim against the general contractor, and there should be consequences for failing to assert the right; third, the specific amount of the general contractor’s disbursement and the payment milestones must be clearly defined, and vague wording must not be used.

When materials operators sign supply contracts, they should handle “back-to-back” payment clauses with caution, and try to clearly specify the final payment deadline to avoid falling into the predicament of “waiting indefinitely for payment.” Construction companies should also adhere to the principle of good faith and must not treat such clauses as a “shield” for withholding goods payment; otherwise, they will bear corresponding legal liability.